A Modest Proposal

To boost Pell Grants and address economic inequity, why not tax income earned via investment of college endowment funds?

Readers of this blog are aware of my none-too-subtle concerns with wealthy campuses that do not exemplify best practices: rather than use their wealth to lower their sticker prices and create greater affordability for more prospective students, they have done just the opposite – they have raised their tuition prices and increased their already obscene levels of per-student expenditures.

But it is more than just a few well-known campuses behaving badly. At a time when American families are only too aware that colleges have become less and less affordable, the underlying cause of this unaffordability is the skewed distribution of revenue to institutions of higher learning in general.

More than one-third of all undergraduates are enrolled in two-year colleges. Some are focused on a two-year degree, but many of them plan to transfer to a four-year school and earn their baccalaureate. This is the least expensive level of higher education, with annual tuition generally around $3,000 – and it is the low cost that has led to swelling enrollments in community colleges.

The public state colleges (as distinct from public research universities), with posted tuitions that are generally less than $9,000 annually, collectively enroll about 3 million students. Most of these campuses have suffered mightily from reductions in state appropriations during the past decade, and are struggling to provide both affordable access and a quality educational experience.

Although there are a relative handful of extremely wealthy private colleges and universities, most private institutions have at best modest endowments, and are heavily dependent on tuition to provide the bulk of their operating budgets. Many are seeing price resistance from their students, and are finding it difficult to increase tuition, resulting in a squeeze between flat revenue and rising expenses.

At the same time, between $25 billion and $30 billion flows annually from philanthropic sources to higher education – an amount that would suggest that higher education is better off than it allows. However, most of this money goes to campuses that are already very wealthy, a classic example of the rich getting richer, while the rest scratch for crumbs.

This sharply skewed distribution of wealth is not, I submit, in the nation’s interest. The handful of very wealthy campuses collectively enroll less than 3 percent of college students – and while these students receive excellent educations, we cannot afford to have higher education become so stratified. Our national interests require that we create excellent educational opportunities for a growing, not a shrinking, fraction of our college-age youth.

But much philanthropic giving is from wealthy alumni who wish to give back to the institutions that helped them become wealthy. We cannot very well tell them to give their money to a needy college with which they have no relationship. How, then, can we address this misdistribution of economic resources?

Well, I’m glad you asked. It seems to me that an answer is at hand – one that would benefit needy students (and, indirectly, benefit the campuses at which these students enroll), yet one that would not cause significant harm to wealthy campuses.

I suggest that the federal government tax income earned through the investment of endowment money at the capital gains rate – currently, 15 percent – and that the government use these monies to augment the number and/or size of Pell Grants. (Note that I am not suggesting that gifted money itself be taxed – only the investment returns.)

What would this mean, financially? Collectively, universities and colleges have more than $400 billion in their endowments. In the fiscal year ending in June 2011, the average return on investments was 19.8 percent, or about $80 billion. A 15 percent tax would have generated about $12 billion to augment Pell Grants. Harvard, with more than $5 billion in investment gains that year, would have been taxed about $75 million – a lot of money, to be sure, but, with a total endowment of more than $30 billion, it is by far the richest university.

For the fiscal year ending in June 2012, endowment returns were basically flat. With no capital gains to speak of, there would have been virtually no money paid in taxes. Universities would not be put in the position of paying taxes in years when they did not do well financially.

The uneven rate of tax returns would create problems in planning the size and number of Pell Grants, but that variation in revenue is not a sufficient reason to abandon this idea. Finding ways to level the higher education playing field, in order to allow more students a chance at using a college degree to climb the socioeconomic ladder, is something on which we should all be focused.

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